The politics of taxation

The decision by Ontario Premier Dalton McGuinty to give in to the NDP demand for a 2 per cent surtax on the super-rich has opened up a can of worms. Now that Canada’s largest province has established the precedent, who’s next?

From Mr. McGuinty’s perspective, the decision was a no-brainer once he was able to persuade NDP leader Andrea Horwath not to tie the extra income to one of her pet projects such as repealing the HST on hydro bills. He was able to announce that any additional revenue from the “NDP tax”, as he cleverly put it, would be applied to reducing the province’s deficit and would be repealed as soon as the books are balanced. The concession was enough to persuade NDP members of the provincial legislature to abstain from the budget vote, thereby ensuring its passage.

The surprise in all this from a political perspective is that Ms. Horwath was not able to leverage her position to wring some concessions from the government on the budget’s hard-line approach to public service salaries and pensions. The NDP draws heavily on the trade unions for support but was unwilling to go to the mat to force the Liberals to back down on their tough stance. Instead, Ms. Horwath settled for what amounts to a bauble.

Soaking the rich has always been part of the NDP’s mantra — make the wealthy and the corporations pay more. The problem is there is no evidence the approach works very effectively. The former Labour government in Britain tried raising the tax rate on the wealthy to 50 per cent as part of its austerity program, hoping to generate £3 billion in additional income. It fell far short of that. Last month the Conservative government’s new budget cut the rate by five percentage points to 45 per cent effective next year. Chancellor of the Exchequer George Osborne said the higher rate only produced a third of the expected revenue while causing “massive distortions”. He added: “No chancellor can justify a tax rate that damages our economy and raises next to nothing.” 

We could see the same phenomenon in Ontario. Premier McGuinty predicted that the 2 per cent surtax would generate about $470 million which would help reduce the deficit more quickly. He’ll be lucky to get half that. Experience proves that the higher the tax rates, the more aggressive people will be in their efforts to avoid paying. For the super-rich, that means hiring top tax professionals to help them figure out ways to achieve that goal. Deferring income, setting up trusts, income-splitting, and changing domiciles are just a few of the ways to do that.

To be clear, I’m not arguing against higher tax rates for the wealthier segments of society. As Warren Buffett has famously pointed out, there is something wrong when his secretary’s marginal rate is higher than his. But tax rates at all income levels should be seen as “fair”. When they are not, tax avoidance and evasion become rampant.

Since the Ontario move has opened this debate, I would argue that personal tax rates at all levels are too high in Canada. Consider someone with a taxable income of $43,000. That is hardly “rich” by anyone’s standards but this person faces a marginal tax rate of 30 per cent or higher in almost all jurisdictions and as much as 38.37 per cent in Quebec.

At $86,000, most Canadians are looking at a marginal tax rate of close to 40 per cent and in some cases much higher – in Ontario, Manitoba, Nova Scotia, and PEI it’s about 43 per cent and in Quebec it’s almost 46 per cent. After taxable income reaches $132,406 we’re all paying the top rate — or at least we will be until Ontario’s new surtax kicks in on July 1 and $500,000 becomes the top bracket.

By contrast, in the U.S. the tax brackets are much wider. A married couple filing a joint return (which is not permitted in Canada) pay a federal marginal rate of only 15 per cent until their combined income exceeds US$70,700. The rate rises to 25 per cent up to US$142,700 and then goes to 28 per cent for income up to US$217,450. Canada’s top 29 per cent bracket cuts in at $132,406. The top U.S. federal bracket, which is 35 per cent, isn’t reached until income passes US$388,351.

At some point, the Harper Conservatives would do the country a favour by focusing on an overhaul of the tax system with these objectives in mind:

1. Eliminate the majority of the tax loopholes and credits that make the system so complicated and which have been exacerbated by Finance Minister Jim Flaherty during his tenure. The revenue produced by the elimination of these tax expenditures can be used to pay for the other reforms that follow.

2. Expand the tax brackets to reduce the burden on lower and middle-income individuals and families.

3. Increase personal allowances to remove more lower-income people from the tax rolls. Britain’s new budget will raise tax-exempt income to the equivalent of $14,677 in April 2013. Canada’s basic personal amount is currently $10,822.

4. Allow for the filing of joint returns.

5. Aim for a top marginal federal-provincial combined rate of 45 per cent. This will require provincial co-operation and may require some federal government incentives.

We need a serious rethink of what has become an overly complex and burdensome tax system. It would be controversial, no question, so when better to do it than with a majority government.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, go here.